Investors should be looking to hold more UK equities

British companies stack up against the best in the world

The Hans Christian Andersen story of the ugly duckling suits the stocks that you should be buying, and their prospects – even if they don’t turn into actual swans.

Andersen wrote the story after learning that he was, in fact, an illegitimate son of the King of Denmark. So the story was a powerful metaphor for him: he wasn’t common after all, but royal.

The same can be said for UK equities, and particularly those that have a domestic focus. Many have turned from ugly ducklings to swans and have really learnt to fly in terms of share price performance.

Just such a stock is easyJet. It is a UK survivor. A few years ago, there was a lot of negativity towards UK equities. Typical news headlines included: “Britain is consigned to three years of 'anaemic’ economic growth”; “Pension schemes slash allocations to UK equities”; and “London stock market is too concentrated”.

In parallel, pension fund consultants and many wealth managers were growing increasingly negative on UK equities. That negativity has seen the proportion of a typical pension fund accounted for by UK equities fall to around 15pc today from around 50pc in the 1990s. In many portfolios, UK stocks have been largely replaced by global equities, alternatives and bonds.

The conventional wisdom then was clear: investors are better off holding global equities than UK stocks. We think differently. We believe that for every global giant there is, in almost every sector of the market, a UK-listed equivalent whose performance over the past five years has been just as good – or even better.

With the right strategy, investors can profit from global economic trends by investing in UK stocks, and in particular from UK stocks with a domestic focus.

But while investors in UK stocks can profit from global economic trends, they also have the option, when the timing is right, to profit from an improving UK economy.

That time is now. Over the past year or so, negative stories about the UK economy have given way to different kinds of headline, such as: “UK growth looks set to be fastest in the West’; “UK growth upgrade hits record”; and “Fresh signs of recovery spur hopes for growth”.

Estimates for GDP growth in the UK are being revised higher. In fact, the UK could be one of the fastest-growing economies in the developed world in 2014. Given this, there are good reasons to hold UK-focused companies in your portfolio.

We use a proprietary stock screen, MARKET, to comb the UK for potential holdings. The tool ranks most of the largest UK-quoted companies and allocates a score from zero to 100.

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Those companies that look cheap, have a decent balance sheet, generate cash, have their earnings estimates increased at a fast rate, have good share price momentum and are fast-growing, all score well.

The result of the screening process is clear. It tells us that the positive story about the UK economy is translating into attractive characteristics at a company level.

Back in 2010, MARKET identified relatively few UK-focused stocks as attractive. Of the 30 most attractive stocks that it identified, only six were what we might define as being UK-focused, that is to say, their earnings were largely derived from the UK, rather than overseas.

Now the stocks at the top of the list have completely changed and of the best 30 stocks identified by the screening tool, more than 20 are UK-focused companies.

It is clear to me that many of the companies we need to be investing in now are what I call UK survivors. These companies are often in a better condition today than they were before the financial crisis and five difficult years have transformed the competitive environment in which they operate.

Examples of some of the strongest performing UK survivors over the past five years include Sports Direct – which has all but eliminated competitors such as JJB Sports. As a result, it can now put up prices and increase the margins on what it sells.

Elsewhere, plant hire company Ashtead has transformed its balance sheet, taking it from near-bankruptcy in 2003 to the FTSE 100 index today.

Meanwhile, easyJet is taking on, and beating, the likes of Alitalia, Air France and BA. Howden Joinery has put numerous small-time kitchen manufacturers across the UK out of business as its smaller rivals simply cannot compete on price.

It would appear, then, that many of the UK’s ugly ducklings have become stock-market swans and that if the runes about UK GDP growth read true, they could still fly higher over the next few years.